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UNIVERSITY OF 

ILLINOIS LIBRARY 

URBANA-CHAMPAIGN 
STACKS 





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Treasury Department United States Internal Revenue 


Excess-Profits Tax Primer 


Prepared by the 
Bureau of Internal Revenue for the Information 
and Assistance of Taxpayers 


Guaranty Trust Company of New York 
140 Broadway 


FIFTH AVENUE OFFICE LONDON OFFICE 
Fifth Avenue and 43d Street 32 Lombard St., E. C. 
MADISON AVENUE OFFICE PARIS OFFICE 


Madison Avenue & 60th Street Rue des Italiens, 1 & 3 


To the Taxpayer 


HE great body of patriotic taxpayers are 

anxious to pay their taxes and thus fulfill 
their whole financial duty to the Government. 
This department is equally anxious to help them 
fulfill that duty without prejudicing their own 
interests or paying a larger tax than under the 
law they are called upon to pay. To attain this 
end, co-operation along the following lines is 
necessary : 

1. File your return promptly. You have until 
April 1 to do this, but you will greatly assist the 
Government by filing your return now. This 
will be to your own advantage, for, if you have 
any problem that requires special attention, the 
sooner your return is in the earlier will your case 
be reached and decided. 

2. Secure from your collector the proper return 
form and read carefully the instructions and 
questions printed thereon. Get at the same 
time a copy of Regulations No. 41 and use the 
index. When in doubt on any point, consult 
your collector or revenue agent, or your banker. 
If still in doubt, answer each question as you 
understand it and send with your return a state- 
ment of the questions about which you are un- 
certain. A decision can then be made at Wash- 


ington, where the administrative authorities are 
as anxious to protect your interests as to obtain 
the revenue. In this way you will be protected 
against penalties. 

3. If you can not determine your invested 
capital, or if for any other reason you believe 
yourself entitled to make claim for assessment 
under section 210 (art. 52 of the regulations), 
make out your return as best you can from the 
information at hand and file with it a full explana- 
tion of the facts, showing wherein information for 
making out a complete return is lacking, or why 
you think you are entitled to assessment under 
section 210. 

4. If you are able to compute the amount of 
your excess-profits tax, you may pay the tax at 
the time you file your return. By so doing, you 
will reduce the great rush in the payment of 
taxes in June. If you pay the tax in advance, 
you may deduct from the amount of the tax due 
a sum equal to 3 per cent. per annum calculated 
from the date of payment to June 15, 1918. 
Taxes may also be paid in installments, provided 
the installments do not extend beyond June 15. 
Your collector will explain how this may be done. 


Danie. C. Roprer, Commissioner. 


Excess-Profits Tax Primer 


General Features 


Tax Applies to Trade or Business 


In the case of a corporation or partnership 
the law expressly provides (sec. 201) that all 
its income, from whatever source derived, shall 
be deemed to be received from its trade or 
business. In this case there is one business 
and one net income. 


In the case of an individual the excess-profits 
tax applies only to that part of the net 
income which is derived from the taxpayer’s 
trade, business, profession, or occupation, 
even though the taxpayer may have other 
income subject to the ordinary income tax. 
Unlike a corporation or partnership, an in- 
dividual may be engaged in two businesses, 
one with invested capital, one with no in- 
vested capital or only a nominal capital. If 


[2] 


he has more than one business with invested 
capital, they will all be regarded as one; and 
if he has more than one business with no 
invested capital, they will be regarded as one. 
If he has both kinds of business, he will be 
regarded as having two businesses. 


It is an Income Tax 


It is an income tax in addition to the 
regular income tax of September 8, 1916, as 
amended, and the war income tax of October 
3, 1917. It is more than a tax on “war 
profits’; it reaches all income in excess of 
a stipulated normal deduction. The tax falls 
into two classes: 

(a) An8 per cent tax imposed by section 209 upon 


trades or businesses having no invested capital or 
merely a nominal capital, e.g., doctors, lawyers, and 


professional or salaried persons in general. Domestic 
corporations under this section are allowed a specific 
deduction of $3,000; domestic partnerships and in- 
dividual citizens or residents a specific deduction of 
$6,000. (See articles 71-74 of Regulations No. 41.) 

(b) A graduated tax, with rates rising from 20 to 
60 per cent, upon the net income in excess of a deduc- 
tion equal to a percentage (varying from 7 to 9 per 
cent) upon the invested capital plus $6,000 in the case 
of an individual or partnership or $3,000 in the case of 


a corporation. Foreign corporations or partnerships 


and nonresident aliens are not entitled to the 
specific deductions of $3,000 or $6,000 respectively. 

An exceedingly important subdivision 
under class (6) consists of those cases in 
which the invested capital—or the net income 
for the prewar period—can not be satis- 
factorily determined. In such cases the as- 
sessment is based largely upon conditions 
or relations existing among representative 
business concerns in a like or similar trade 
or business. (See sections 205 and 210 
of the law and articles 18, 24, and 52 of 
Regulations No. 41.) 


Classification of Taxpayers 


In the case of a corporation or partnership 
all of its income will be held to be of the 
same class as the income from its principal 
trade or business. There is one income and 
one tax. (Article 14 of Regulations No. 41.) 

In the case of an individual there may be 
income subject to the 8 per cent rate and 
income subject to the graduated rates, in 
which case there will be two deductions and 
two taxes—but not more than two. (See 
articles 35 and 36 of Regulations No. 41.) 

In general, the taxpayer can not decide for 
himself whether he is subject to the 8 per 
cent tax or the graduated tax, but must fill 
out the ordinary form so far as possible n 
order that the department may decide into 
which class he properly falls. Exception, 
however, is made in the case of individuals 
whose income consists wholly of salary or the 
earnings of personal service and who employ 
no invested capital in their trade or business. 
In such cases the excess-profits tax will be 


[3] 


computed from the data on the income tax 
return Form 1040. 


Income Subject to Tax—Corporations, 
Partnerships, and Individuals 


1. A partnership makes $80,000, one-fourth of 
which is paid to a special or silent partner 
who takes no real part in the conduct of the 
business. Is the partnership taxable with 
respect to the $20,000 paid to the silent 
partner? 


Yes. The partnership is engaged in busi- 
ness and is taxable upon its entire net 
income. However, no member of the 
partnership as an individual is subject to 
excess-profits tax on his share of the part- 
nership profits. (See article 41 of Reg- 


ulations No. 41.) 


2. A corporation has been making income-tax 
returns on the basis of a fiscal year ending 
June 30. Net income for the last six months 
of 1916 was $1,000,000. The losses for the 
first six months of 1917 were $400,000. Is 
there any taxable income subject to excess- 
profits tax for the year 1917? 


Yes. The profits for the full fiscal year 
were $600,000. One-half of the fiscal year 
falling in the calendar year 1917, the cor- 
poration will be taxable on a proportion- 
ate amount. The corporation should 
make a return for the full fiscal year, 
compute the tax that would ordinarily be 
due for an entire year, and then take a 
proportionate part (in this case one-half) 
as the tax to be paid. (See article 19 of 
Regulations No. 41.) 


3. Is a “‘ Massachusetts trust” taxed as a cor- 
poration or partnership? 


As a corporation. The term “corpora- 
tion”’ includes joint-stock companies or 
associations, no matter how created or 
organized. (See article 2 of Regulations 


No. 41.) 


4. A. B., an attorney, bought a house and lot in 
June, 1917, received rent from tt until Octo- 
ber, 1917, and then sold uz at a profit. Does 
he pay on rentals and the profit? 


An attorney whose business is of a purely 
personal-service nature is taxable at 8 per 
cent under section 209. He might buy 
real estate for investment and later sell it 
at a considerable profit, but this being an 
isolated transaction and not a business, 
the income and profits therefrom would 
not be subject to excess-profits tax. He 
would be entitled to one deduction of 
$6,000. 


. A lawyer with a considerable income from 
his practice, receives fees as director in two 
banks and an insurance company. Are 
such fees taxable? 


Regular service as a director constitutes 
an occupation or business and the fees 
therefrom, along with the regular income 
of the lawyer from his practice, are taxa- 
ble at 8 per cent under section 209, with 
one deduction of $6,000. 


. A landlord renting a large farm on shares, 
which requires considerable attention, em- 
ploys an agent to look after his interests, see 
that the farm buildings are kept in good 
repatr, collect and market his share of the 
crops, etc. Is the rental taxable? 


Yes; at the graduated rates. The land- 
lord is engaged in business with respect to 
the farm and the fact that he employs an 
agent to look after his business does not 
relieve him from the tax nor entitle him to 
the 8 per cent rate. 


. John Smith owns and operates a dry goods 
store. He also owns and operates a shoe 
store. Is he allowed to report these bust- 
nesses separately with a separate deduction 
for each? | 


No; the rule is that there may be one de- 
duction for a business with no invested 


[4] 


10. 


hy By 


capital or merely a nominal capital (per- 
sonal service), and another deduction for 
an unrelated business having invested 
capital, but there may not be more than 
one deduction for businesses taxed under 
section 201, or for businesses taxed under 
section 209. 


. I conduct two entirely separate businesses 


both employing invested capital. Should I 
make a combined return for the two bust- 
nesses, or a separate return for each bust- 
ness? 


You should make one return covering the 
two businesses. 


. A contractor and dealer in real estate also 


lists property owned by others and does 
business as a real estate agent or broker. 
How is he taxed? 


These activities are so interrelated as to 
constitute one business. If the individ- 
ual employs in this real estate business 
a considerable amount of capital he is 
taxable at the graduated rates under 
section 201. 


I am a doctor and also manage and direct 
a small factory which I own. How am I 
taxed? 


You will pay a tax of 8 per cent on the 
fees from your medical practice under 
section 209, and a graduated tax on the 
income from your factory. Under sec- 
tion 209 you will get a deduction of 
$6,000; under section 201 a specific de- 
duction of $6,000 plus a_ percentage 
deduction of from 7 to 9 per cent on the 
capital invested in the factory. 


A school teacher buys a farm upon which 
owl is discovered, and sells the farm at a 
large profit. Is such profit subject to ex- 
cess-profits tax? 


Not unless the teacher is also a farmer or 
buys and sells real estate with sufficient 
frequency to make the latter one of his 


12. 


13. 


14. 


occupations. The teacher may have an 
occupation or business other than teach- 
ing the profits from which would be 
taxable, but if he buys a farm simply 
as an isolated investment and does not 
run it, the profits from its sale would 
not be subject to the tax. (See ques- 
tion 12.) 


A manufacturer who has been in business 
for many years sells his factory at a con- 
siderable profit. Is such profit subject 
to excess-profits tax? 


Yes; because the profit in this and similar 
cases is a normal result of winding up 
the business; it is part of the business. 
On the other hand, if the manufacturer 
had bought a farm and sold it at a profit, 
the profit would not—if the transaction 
were isolated—be taxable. Profit from 
an isolated transaction outside of his 
business is not taxable. Profit from an 
isolated transaction connected with his 
business is taxable. 


I am a traveling salesman, working wholly 
on a commission basis. I earn $15,000. 
My traveling expenses are $3,000. My 
house advances me $6,000 per year, giwing 
me the rest of my commissions at the end 
of the year. May I consider that I am 
in business and allow myself a salary of 
$6,000, leaving a profit of $6,000 for the 
business itself? In that case I should be 
entitled to a deduction of $6,000 for the 
business and $6,000 against my salary and 
I should have no excess-profits tax to pay. 


No. You should enter the $15,000 in 
block A on Form 1040, making proper 
deduction for expenses. You would then 
have a net income of $12,000 of which 


$6,000 would be taxable at the 8 per cent 
rate. 


An indwidual who recewed a salary of 
$8,000 during the taxable year has a minor 
son who earned $800 during the taxable 


[5] 


15. 


16. 


17. 


18. 


year in a separate occupation. Must 'the 
$800 be included in the income of the par- 
ent subject to excess-profits tax? 


No. The father is not engaged in busi- 
ness with respect to the income of his 
minor children earned in a separate and 
distinct occupation. 


Deductions 

A corporation had a net income of $10,000 
in 1911, $8,000 in 1912, and a loss of 
$2,000 in 1913. What is the “average 
amount of the annual net income of the 
trade or business during the prewar period,” 
for the purpose of determining the per- 
centage deduction? 


$6,000 ($18,000 divided by 3). The loss 
of $2,000 is disregarded inasmuch as the 
income tax law does not permit the loss 
of one year to affect or reduce the profit 
of another year. 


A firm commenced business April 1, 1911. 
What period should it use to determine 
its prewar earnings and invested capital? 


All of the years 1912 and 1913. The 
year 1911 is disregarded, as the law 
provides that only entire calendar years 
shall be counted. (See section 200.) 


What percentage deduction 1s gwen a tax- 
payer who started in business after Janu- 
ary 1, 1913? 

Eight per cent of the invested capital. 
(See section 204 of the law and article 
21 of Regulations No. 41.) 


Jones was in the hardware business during 
the prewar period. He made more than 
9 per cent on his invested capital. In 
1914 he sold the hardware business and 
established a furniture store and is making 
over 9 per cent. What percentage deduc- 
tion does he get? 

Eight per cent since he is now carrying on 
a business in which he was not engaged 
during the prewar period. However, if 


19. 


20. 


he had bought an established furniture 
business having prewar earnings of nine 
per cent, he would be allowed nine per 
cent, the business being a continuation 
of a business with prewar experience. 
(See section 204 of the law and article 22 
of Regulations No. 41.) 


Smith bought a hotel business in 1914 which 
had been in existence during the prewar 
period, but he is unable to ascertain what 
was us average invested capital for that 
period. What ts his percentage deduction? 


He should compute the tax in the first in- 
stance on the basis of a seven per cent 
deduction, but may file a claim (with ex- 
planation) for final assessment under the 
provisions of section 210 (articles 24 and 
52 of Regulations No. 41), and if the 
Secretary of the Treasury is unable sat- 
isfactorily to determine the invested cap- 
ital, the percentage deduction will be com- 
puted at the same rate per cent as in the 
case of representative individuals engaged 
in a like or similar business. 


An indiwwidual is engaged in the manufac- 
turing business. He makes annual contri- 
butions to a near-by hospital in which in- 
jured employees of his establishment are 
cared for. He also makes contributions to 
his church and to the public library. Is he 
allowed to deduct these contributions in 
computing his net income for purposes of 
the excess-profits tax? 


The contributions to the hospital would 
constitute a proper deduction, since they 
have a reasonable connection with his 
business, and may be considered as com- 
ing’ from the business rather than from 
the ‘individual in his personal capacity. 
Such'contributions will be allowed up to 
fifteen per cent of the income of the busi- 
ness. 

The contributions to the church and the 
library will be regarded as made by the 
individual\:in’ his personal capacity and 


[6] 


21. 


22. 


23. 


24., 


are not allowable deductions from the in- 
come of the trade or business for the pur- 
poses of the excess profits tax. (See arti- 
cle 37 of Regulations No 41.) 


A partnership has been in the habit of mak- 
ing contributions to various churches, local 
charities, and the Y. M. C. A., and charg- 
ing the amounts off to profit and loss at the 
end of the year. Will it be allowed to de- 
duct these contributions in computing tts 
net income for purposes of the excess-profits 
tax? 


No. These contributions are not con- 
nected with the trade or business. The 
same rule applies in the case of a partner- 
ship as in the case of an individual. (See 
section 206 of the law and article 37 of 
Regulations No. 41.) 


An incorporated department store occa- 
sionally contributes to local charities, hospi- 
tals, etc. Are these items deductible? 


No. Donations which do not have in 
them the element of compensation are 
considered gratuities and are not allow- 
able deductions from gross income as an 
expense of operation or maintenance or 
under any other head. (See articles 134 
and 135, Regulations No. 33 (Revised), 
governing the collection of the income 
tax.) 


Several of our regular employees have en- 
listed in the service of the United States in 
different capacities, some in the Army, 
others in the Navy, Food Administration, 
etc. We have continued their salaries dur- 
ang thew absence. May we charge these 
payments as expense in computing our 


profits? 
Yes. 


Four other attorneys and myself conduct a 
law business under a partnership arrange- 
ment. There 1s no invested capital. It is 
our custom to distribute the entire net in- 


come to the partners as salaries, leaving the 
partnership no net profits. May we con- 
tinue to do this? If the partnership makes 
a return it will be entitled to a deduction of 
$6,000 and the several partners are each 
entitled to the same deduction. In other 
words, if we make a separate return for the 
partnership there will be a total of six 
$6,000 deductions, whereas if all the net 
income is distributed and taxed to the indi- 
vidual partners there will be only five such 
deductions. In the latter case the Govern- 
ment will collect $480.00 more tax. We 
prefer not to make a partnership return. 


The department will not recognize a 
division or sharing of the entire net in- 
come of a partnership as an allowable 
method of determining the salaries of the 
partners, although in rare cases the sal- 
aries may exhaust or even exceed the net 
income of the partnership. (See article 
32 of Regulations No. 41.) Every do- 
mestic partnership having a net income 
of $6,000 or more without deducting 
salaries or interest paid to partners must 
make a return of income on Form 1065. 


Concerns in Operation Only Part of 
Taxable Year 


25. A‘ partnership was established and began 


operations August 1,1917. The capital in- 
vested was $300,000 and the net income for 
the five remaining months of 1917 was 
$60,000. What ts the tax? 


As the net income covers only five- 
twelfths of a year, the deduction and the 
invested capital must be brought to the 
same basis. Five-twelfths of the total 
deduction for a full year is $12,500. (The 
percentage deduction for a full year 
would be $24,000 and the specific deduc- 
tion would be $6,000, a total of $30,000. 
Five-twelfths of the last figure is $12,500.) 
Five-twelfths of the total invested capital 
is, $125,000. Thus in this case the tax 


(7] 


26. 


Q7. 


28. 


would be computed on the basis of an in- 
vested capital of $125,000, net income of 
$60,000, and a total deduction of $12,500. 
The tax would be $20,750. 


A corporation organized July 1, 1917, 
makes $2,400 in the last half of that year. 
Is it required to make return and pay ex- 
cess-profits tax? 


Yes. A corporation engaged in business 
for only a part of the year must make re- 
turn if its net income is at the rate of 
$3,000 or more per annum. A similar rule 
applies to an individual or partnership 
engaged in business for only part of the 
taxable year: a return must be made and 
the excess-profits tax paid if the net in- 
come for the taxable year is at the rate of 
$6,000 or more. (This answer does not 
apply in the case of a corporation or 
partnership whose first fiscal year ends 
in 1918 and which has secured permission 
to make its return on the basis of its fiscal 
year.) 


Invested Capital 


Section 207 (clause 3) authorizes the inclu- 
ston in invested capital of “paid in or 
earned surplus and undivided profits used 
or employed in the business.” Can a cor- 
poration or partnership have any surplus or 
undwided profits which for purposes of the 
excess-profits tax will not be deemed to be 
used or employed in the business? 


All the surplus and undivided profits of a 
corporation or partnership (exclusive of 
undivided profits earned during the year) 
will, unless invested in assets the income 
from which is not subject to the excess- 
profits tax, be deemed to be used or em- 
ployed in the business and may be in- 
cluded in the invested capital. (See arti- 
cle 62 of Regulations No. 41.) 


A corporation balances its books monthly, 
carrying profits into surplus account. Is 
the capital as of January 1st increased for 


29. 


30. 


31. 


the purposes of the excess-profits tax by the 
addition of these monthly profits? 


No. The law specifically excludes undi- 
vided profits earned during the taxable 
year. The profits accumulated during the 
year, even though entered on the books 
as surplus before the close of the year, can 
not be counted as additions to the capital 
for that year. (See article 61 of Regula- 
tions No. 41.) 


In computing invested capital for the pur- 
poses of the-excess-profits tax, may a cor- 
poration take as the value of its capital stock 
the amount fixed by the department for the 
purposes of the capital-stock tax? 


No. Each return must be prepared in ac- 
cordance with the provisions of the law 
under which it is made. 


According to section 207, bonds (other than 
obligations of the United States), the in- 
come from which is not subject to the excess- 
profits tax, can not be included in invested 
capital. Section 200 states that ‘‘ The term 
‘United States’ means only the States, the 
Territories of Alaska and Hawaii and the 
District of Columbia.’ May State bonds 
be included in invested capital? 


No. The above definition applies only in 
a geographical sense. The term “United 
States” in the parenthetical clause above 
is not used in a geographical sense. 


Hence the .term “obligations of the 


United States” means only obligations 


of the Federal Government. 


In 1901 a corporation was organized and 
took over the assets of a dozen going con- 
cerns, wssuing therefor $25,000,000 of 
capital stock. The assets consisted of 
vartous plant structures, equipment, real 
estate, patents, and good will. At the 
tume of the transaction all of these items 
were entered in a lump sum and no attempt 
was made to indicate the specific amounts 
of stock issued for the respective kinds of 


[8] 


32. 


33. 


property. It rs shown that at that time 
the tangible property was worth $10,000,- 
000, the patents $2,000,000, and the good 
will not less than $7,000,000. How is the 
invested capital to be computed? 


In accordance with article 59 of Regula- 
tions No. 41, it will be presumed that 
$12,000,000 of the stock was issued for 
the tangible property and the patents and 
that $13,000,000 was issued for good will. 
The tangible property will be taken at its 
value as of January 1, 1914, but not to 
exceed $10,000,000, the par value of the 
stock deemed to have been issued for it. 
The patents will be taken at their value 
at the time of acquisition, namely, $2,000,- 
000. Although $13,000,000 of stock was 
issued for the good will, it can be taken 
at only $5,000,000, i.e., 20 per cent of the 
total stock outstanding on March 3, 1917. 


A banking corporation began operations in 
1902. In the course of twelve years, for 
reasons of conservatism, the bank charged 
off practically the entire value of tts build- 
ing, and since January 1, 1915, has been 
carrying i on its books at the nominal 
figure of $1.00. Can any of this value 
be restored for the purpose of computing 
invested capital? 


Yes. The building may be taken at cost, 
less a fair allowance for depreciation. 
However, any amounts which may have 
been allowed as a deduction for depre- 
ciation under the income-tax law can 
not be restored. 


A farmer bought a piece of land December 
1, 1918. He has put no new money in 
the business, but has spent all his uncome 
from the land for tile and ditching. The 
farm cost originally $4,000, and 1s now 
easily worth $10,000. In computing 1n- 
vested capital should the value as of January 
1, 1914, be taken? 


No. The property will be valued at cost | 
less depreciation (on buildings, ete.), plus 


34. 


35. 


the amount of earnings from year to year 
invested in the permanent improvement 
of the property. 


Article 18 of the Regulations says that 
when the deduction is determined under 
Article 24 a “constructive” capital will be 
used for applying the rates of taxation. It 
may be that in some cases tt will be im- 
possible to determine satisfactorily the in- 
vested capital for the prewar period, but 
quite possible to determine the invested 
capital for the taxable year. In such cases 
the deduction will be determined under 
Article 24. Will the constructive capital 
described in article 18 be used? 


No. The constructive capital is to be 
used only in cases where it is impossible 
to determine satisfactorily the invested 
capital for the taxable year. 


In 1900 a corporation was organized and 
took over a mining property then valued at 
$1,000,000. For this property the cor- 
poration issued stock to the amount of 
$1,000,000. As a result of development, 
the discovery of new ore bodies, etc., the 
property increased in value until in 1910 
after an appraisal it was entered on the 
books at $10,000,000 and the surplus was 
increased accordingly. In 1917 another 
appraisal was had and the value of the 
property was then fixed at $15,000,000. 
The balance sheet of the corporation now 
shows capital stock of $1,000,000 and a 
surplus of $20,000,000, of which $14,000,- 
000 1s represented by the appreciation in 
value above described. May the appraised 
value of the property be taken as the basts 
for computing invested capital? 


No. The excess-profits tax law expressly 
places the computation of invested capital 
upon the basis of the cash and other 
property actually put into the business, 
plus the earned surplus and undivided 
profits, and not upon that of a present 


[9] 


36. 


37. 


valuation or appraisal of its assets. 
Returns in which the invested capital 
includes surplus or undivided profits 
computed upon present values as deter- 
mined by an appraisal can not be ac- 
cepted. 


In 1907 a corporation acquired a manu- 
facturing plant valued at $500,000, issuing 
therefor $500,000 of capital stock. The 
books of the corporation on December 31, 
1916, showed a surplus of $1,000,000, ac- 
cumulated through the earnings of the busi- 
ness. Most of this surplus was invested 
in increased plant equipment, ete. In 
December, 1917, the property was ap- 
praised (as of January 1, 1917) by an 
appraisal company and the value fixed at 
$2,500,000, or $1,000,000 more than the 
values previously shown on the books. This 
increase was attributable mainly to in- 
creased value of land and in part to larger 
values placed by the appraisal company 
upon the machinery and equipment. May 
this appreciation of $1,000,000 be regarded 
as an earned surplus and the value fixed 
by the appraisal company in December, 
1917, be taken as a basis for computing 
invested capital for that year? 


No. 
case stated in question No. 35. 


The same rule applies here as in the 
For the 
purposes of the excess-profits tax law 
appreciation in the value of property will 
not be regarded as earned surplus, and 
an appraisal of property upon current 
values will not be accepted as a basis for 
computing invested capital. 


A proprietary medicine company has spent 
large sums in advertising and has thereby 
built up a good will. May these sums be 
included as expenditures for a capital asset? 


If the money was spent from original 
capital the original capital is of course 
allowed. But if these advertising bills 
were paid from income and the amounts 


38. 


39. 


40. 


charged to general expense they can not 
be included as capital. Good will can be 
included only when bought and paid for 
specifically as such. 


Returns 


A corporation is engaged in the brokerage 
business, employing only a nominal capi- 
tal. According to article 73 of the regu- 
lations, it is taxable at the 8 per cent rate 
under section 209 of the law. Its income 
tax return ts made out on Form 1031. 
Must tt also make out a return on Form 
1103, which apparently relates only to 
corporations having an invested capital? 


Yes. Every corporation claiming to have 
only a nominal capital must file a return 
on Form 1103, however small its capitali- 
zation may be. 


If a corporation claiming to have only a 
nominal capital files a return on Form 
1103, will this not be construed as an 
admission that it has invested capital and 
is taxable at the graduated rates under 
section 201? 


No. This return is required for the sake 
of information, so as to enable the de- 
partment to determine the justice of the 
claim. The two forms (1031 and 1103) 
should be filed together and should be 
accompanied by a statement describing 
the nature of the business, the purposes 
for which the capital is employed, and 
any other facts tending to show that the 
corporation is of a kind properly taxable 
under section 209, at the 8 per cent rate. 


In the case of a corporation claiming to 
have only a nominal capital, on which 
form and under what schedule should the 
tax at the 8 per cent rate be computed? 


(a) In the case of a domestic corporation, 
take the net income as shown in item 6, 
schedule I of Form 1103, compute 8 per 
cent on the amount thereof in excess of 


[10] 


41. 


42. 


$3,000, and enter the result as item 12 on 
Form 1031. (b) In the case of a foreign 
corporation, if the net income shown in 
item 6, schedule I of Form 1103, is in 
excess of $3,000 the tax will be 8 per cent 
upon the whole amount and should be 
entered as item 12 on Form 1031. (c) In 
either case it should be noted under item 
12 that the tax is computed at the 8 per 
cent rate. 


If a corporation during 1917 made less 
than 7 per cent on tts invested capital, rs ut 
required to file an excess-profits return? 


Every corporation having an income for 
the taxable year of $3,000 or over is 
required to file an excess-profits return, 
even though its total deduction may be 
in excess of its net income. 


On Form 1065 (partnership-income return) 
itts stated on page 1 under “5. Excess Profits 
Tax,” that “if the partnership reports any 
income from sources other than those in- 
cluded under A, page 3, it must make a 
return and compute the amount of tax (an 
any) on Form 1102.” If a domestic part- 
nership rendering professional or personal 
services and reporting its main income in 
block A, also reports a small amount of 
interest from bank balances, etc., in block 
F, will it be required to make a return 
on Form 1102? 


No. The income of a partnership or 
corporation (unlike that of an individual) 
must be taxed as a unit—all under the 
graduated rates or all at 8 per cent. 
(See article 14 of Regulations No. 41.) 
If the partnership has a substantial 
amount of capital (however invested), 
return must be made on Form 1102 for 
purposes of information. (See answers 
38 and 39 above.) But if the partner- 
ship has only a small capital and is 
clearly taxable at the 8 per cent rate as 
to the income from its principal trade 
or business, any income which it derives 


43. 


44. 


45. 


from other sources will be taxed in the 
same manner and there will be no occa- 
sion for a return of invested capital. 


In the case stated in question No. 42, how 
should the tax be computed? 


In every case the excess-profits tax of a 
partnership is to be computed upon the 
net income, as shown in block G, page 4, 
of Form 1065. In the case above stated 
this will consist of the sum of the totals 
reported under Aand F. The tax will be 
8 per cent upon the amount by which 
this sum exceeds $6,000. (The statement 
on page 4 of Form 1065 that the excess- 
profits tax on a business with no invested 
capital or only a nominal capital will be 
“8 per cent of the amount by which the 
net total reported under A, page 3, exceeds 
$6,000, or in the case of a foreign partner- 
ship, 8 per cent of the entire net total 
reported under A” applies only in cases 
where the entire net income falls in 


block A.) 


Will every partnership reporting income 
from business under block B, page 3 of 
Form 1065, be taxable at the graduated 
rates under section 2012 


Not necessarily. Every partnership re- 
porting income under block B must make 
a return on Form 1102. But if it is clear 
that its princtpal trade or business con- 
sists in rendering personal service (income 
reported under block A) and is taxable 
at the 8 per cent rate, all of its income 
will be taxed at that rate even though a 
part of it may be derived from “invested 
capital.” 


Block C, on page 3 of Form 1065, provides 
space for entering profits from sale of real 
estate, stocks, bonds and other property. If 
a partnership sustains a net loss from such 
transactions can ut take account of such loss 
im computing its net income subject to the 
excess-profits tax? 


[11] 


46. 


47. 


48. 


49. 


Yes. The loss should be entered in red 
ink or as a negative quantity in block C. 


On the individual excess-profits tax return 
(Form 1101) there appears under schedule 
B a column for entering the “Cost” of 
assets acquired except “tangible property 
put into the business.” Where should the 
value of tangible property put into the bust- 
ness be entered? 


In the same column (column 2, headed 
“Cost”). If the property was put in 
before January 1, 1914, enter the value 
as of that date; if put in on or before that 
date, enter the value as of the time when 
putin. In all such cases enter along with 
the description of the asset the date when 
it was paid in. 


Tf an indiwidual who keeps books reports his 
invested capital in schedule A on Form 
1101, must he also fill out schedule B? 


Not necessarily. If invested capital is 
reported in schedule A, the return should 
be accompanied by a statement explain- 
ing adjustments. In many cases, how- 
ever, it may be advisable to fill in the 
spaces provided in schedule B for the de- 
scription of assets and their proper valua- 
tion. This may be useful in connection 
with the explanatory statement. 


Item 7 in schedule A of Form 1101 (indi- 
vidual excess-profits tax return) eclls for 
the excess of inadmissible assets over lia- 
bilities. Should an individual reporting 
his invested capital in schedule A specify 
the amount of liabilities and of inadmissi- 
ble assets respectively under items 23 to 27 
of schedule B? 


Yes. This is the most convenient way of 
explaining item 7 of schedule A. 


How does a member of a partnership, in 
making his indwidual income-tax return, 
report his credit for his proportionate share 
of the excess-profits tax assessed against the 


50. 


partnership? Does he add that share to 
any excess-profits tax assessed against him 
as an individual and report this sum in 
block L on Form 10402 


No. On Form 1065, page 4, the partner- 
ship takes credit for its excess-profits tax 
(blocx J) before arriving at the net in- 
come to be shared by the partners (block 
K). So the individual partner in report- 
ing his total net income (Form 1040, 
block K) has already deducted his pro- 
portionate share of the partnership excess- 
profits tax and he may not again include 
that share as a part of his deduction under 
block L of Form 1040. He should enter 
in that space only the amount of excess- 
profits tax, if any, assessed against him as 
an individual. 


On page 2 of Form 1065 (partnership in- 
come return), under the heading “Other ex- 
penses”’ 1s the following instruction: “Do 
not deduct salary for any partner’s services 
unless such salary ts paid in accordance 
with a prior agreement properly recorded on 


{12} 


51. 


the books of the partnership.” Does this aS 
instruction supersede article 32 of the Reg- 


ulations? 


No. 
March 1, 1918, a salary deduction for 
services actually rendered will be allowed 
regardless of whether a previous agree- 
ment had been made. 


A corporation in which most of the stock is 
owned by tts officers has in the past voted to 
us officers only nominal salaries as drawing 
accounts. In computing net income for 
purposes of the excess-profits tax may the 
corporation deduct as items of expense 
amounts which would constitute reasonable 
compensation for the services actually ren- 
dered by its officers? 


Yes, if a satisfactory explanation is given. 
For any period prior to March 1, 1918, 
reasonable salaries for services actually 
rendered may be deducted, even though 
the full amounts had not been formerly 
voted as salaries by the corporation. 





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